Student Debt: How Much Is Too Much?

Last Updated Mar 12, 2010 9:48 AM EST

I often get questions from readers about their personal finance issues. Periodically I'll answer them here. If you have questions you'd like to ask, please email me by clicking on the "Contact Ray Martin" link to the left.

Dear Ray, If you could give one piece of advice concerning financial planning to students, who often have to take on significant debt, what would it be?
It's no surprise that another consequence of the economic downturn and recession is that more students will be taking on more student loans as their parents are saving less for their future college tuition.

According to How America Saves for College, an annual study by Sallie Mae, a leading student lender, parent's confidence in their ability to save for college has declined sharply over the past year. One-third of parents said they are saving less this year than last, and 41 percent said they have saved nothing at all during the past year.

According to the study, families are saving an average of $2,676 for college annually, or 3.6 percent of their annual income. But the study estimates parents need to save 5.7 percent of their income annually to meet their savings goal by the time their child goes to college.

How do parents think they'll get the money to pay for their child's college costs? Nearly half (47 percent ) of parents surveyed said they expect to use student loans to pay for college, up from 37 percent last year. But that's not necessarily a viable option given the difficulties and limitations of students loans these days.

This trend means more students will take on an amount of debt than they cannot possibly afford on their income when they graduate. A young worker starting out with a $30k income from their first job and over $100k in student loans is in deep trouble, unless they're a doctor, lawyer, or Wall Street banker. And even then, it's no sure thing.

Here's my rule for student loans: Parents and their students should limit total student loan debt to no more than one times the student's expected average annual pay over their first ten working years.

Here's how it works: if you expect that on average over the ten years following graduation, you'll earn about $50,000 a year (for example starting out at $30k on year one and ending at $85k on year ten), then your student loans should not exceed $50,000 when you graduate...and less is better. Keeping college loan debt within this limit ensures a reasonably affordable payment and payoff within ten years. To stick to this rule students (and their parents) should consider lower cost college options, such as in-state schools and community college for their first two years. A college education is typically a good investment in a student's human capital, but over investing can cause them to be hopelessly mired in debt, resulting in significant long-term financial damage. Keeping college loan debt within this limit ensures a reasonably affordable payment and payoff within ten years.

To stick to this rule students (and their parents) should consider lower cost college options, such as in-state schools and community college for their first two years. A college education is typically a good investment in a student's human capital, but over investing can cause them to be hopelessly mired in debt, resulting in significant long-term financial damage.
  • Ray Martin

    View all articles by Ray Martin on CBS MoneyWatch»
    Ray Martin has been a practicing financial advisor since 1986, providing financial guidance and advice to individuals. He has appeared regularly as a contributor on the CBS Early Show, CBS NewsPath, as a columnist on CBS Moneywatch.com and on NBC-TV's morning newscast TODAY. He has also appeared on the Oprah Winfrey Show and is the author of two books.

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